The IRS Did Not Properly Implement Law Penalizing Erroneous Refunds

The IRS Did Not Properly Implement Law Penalizing Erroneous Refunds

WASHINGTON – By incorrectly interpreting Federal law, the Internal Revenue Service (IRS) significantly limited the number of erroneous tax refunds and improper tax credit claims on which it could assess penalties, according to a study released publicly today by the Treasury Inspector General for Tax Administration (TIGTA).

The Small Business and Work Opportunity Tax Act of 2007 amended the Internal Revenue Code to enhance the IRS’s ability to seek monetary penalties for the growing number of erroneous tax credit and refund claims. Under the law, taxpayers who claim excessive tax credits or refunds may be penalized up to 20 percent of the erroneous tax credit or refund claim. TIGTA conducted its audit to determine whether the IRS is properly assessing the erroneous claim for refund or credit penalty on individual tax accounts.

TIGTA found that the IRS incorrectly interpreted the erroneous refund penalty law, which significantly limited the types of erroneous tax refund or credit claims to which the penalty would apply. The IRS assessed only 84 erroneous refund penalties totaling $1.9 million between May 2007 and May 2012.

In response to concerns raised from various IRS functions, the IRS Office of Chief Counsel subsequently revised its interpretation of the law as to when the erroneous refund penalty could be assessed and issued an updated memorandum in May 2012.

Although the IRS revised its interpretation of the law, it has not developed processes and procedures to enable those functions (Campus Operations) that disallow the majority of individual tax credits to assess the penalty. For example, in the year after the IRS revised its interpretation of the law (June 3, 2012, through May 25, 2013), there were 709,123 individual tax credits disallowed by Campus Operations for which the IRS could have potentially assessed erroneous refund penalties totaling more than $1.5 billion.

“I am troubled that even though the IRS has revised its interpretation of this law, it has still failed to establish processes to assess penalties on the majority of disallowed tax credit claims,” said J. Russell George, Treasury Inspector General for Tax Administration. “Taxpayers who seek refunds or credit claims that have no reasonable basis in law must be penalized, for they create unnecessary burden on both the IRS and the American people by straining resources and impeding tax administration.”

IRS management raised concerns about the costs and benefits of establishing processes and procedures for the Campus Operations to assess erroneous refund penalties, but has not provided any documentation and/or analysis to support the validity of these concerns. In view of the significant problem of erroneous claims for credits and refunds and the related costs to the Government, TIGTA believes that the IRS should put appropriate procedures and processes in place to comply with this section of law.

TIGTA recommended that the IRS develop processes and procedures to enable Campus Operations to assess the erroneous refund penalty for disallowed credit claims that are excessive and do not have a reasonable basis. The IRS agreed with the recommendation and stated that a cross-functional team of affected stakeholders will determine the operational and procedural changes needed to integrate assessment of the erroneous refund penalty into the Campus Operations.

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